Citi, BofA may need more capital after stress tests

Citigroup Inc may have to raise more capital after preliminary results of its stress test from U.S. regulators, people familiar with the matter said, and Bank of America Corp may need billions more, the Wall Street Journal reported.

The reports on Tuesday triggered a new round of guesswork and analysis on Wall Street as investors tried to figure out which other banks might face pressure to raise capital.

Wells Fargo & Co's shares fell as much as 5 percent, while Bank of America and Citigroup shares fell as much as 10 percent and 7 percent, respectively.

Bloomberg reported on Wednesday that at least six of the banks that underwent the tests require additional capital, citing people briefed on the matter.

Some of the lenders may need extra cash injections from the government, but most of the capital is likely to come from converting preferred shares to common equity, the people told the agency.

Late on Tuesday, the Journal reported that Citi had asked the U.S. Treasury for permission to pay special bonuses to employees. The bank is also looking into ways to free its energy-trading unit, Phibro, from pay restrictions and is considering a spinoff into an independent hedge fund or bringing in outside investors, the paper reported.

Bank of America may need to raise as much as $70 billion to maintain an acceptable tangible common equity ratio -- a measure of capital strength -- if unemployment rises, analysts at FBR wrote in a report on Tuesday.

Both Citi and Bank of America posted better-than-expected first-quarter results, but analysts have questioned whether the improvement can last given looming credit losses and the surprisingly high trading profits and one-time gains that boosted the results.

If you were to ask people last week which banks would most likely have to raise more capital, I think Bank of America, Citigroup would have been the common answer, said Walter Todd, a portfolio manager at Greenwood Capital Associates.

Each bank has received $45 billion of capital injections under the U.S. government's Troubled Asset Relief Program, more than any other major bank.

But both banks are also likely to face substantially more consumer credit losses as U.S. unemployment reaches its highest level in a generation. Bank of America averaged more than $600 billion of consumer loans during the first quarter, while Citigroup averaged more than $500 billion.

These loans will generate interest income, but any interest income may be overwhelmed by credit losses, analysts said, and Citigroup and Bank of America only have small cushions to absorb these losses by one measure.

Citi's tangible common equity ratio was 1.66 percent at the end of the first quarter. Converting preferred shares into common, coupled with the $2.7 billion sale of a stake in Smith Barney brokerage unit into a joint venture with Morgan Stanley, should raise its tangible common equity ratio to 4.97 percent, Fox Pitt Kelton analysts wrote in a report two weeks ago.

Bank of America's tangible common equity ratio is about 1.8 percent. If unemployment rises as high as 12 percent, it would need $60 billion to $70 billion to maintain its tangible common ratio above 3 percent -- expected to be the government's required level for banks -- according to analysts at FBR Capital Markets.

Some analysts argue that TCE levels above 5 percent are necessary for a bank to truly be healthy as the economy wrestles with the highest unemployment rate in 25 years.

Citigroup can raise additional capital by adding more trust preferred securities to its planned exchange of up to $52.5 billion of preferred securities for common stock, a person familiar with the matter said on Tuesday.

Bank of America shares fell 8.63 percent to $8.15, while Citigroup shares fell 5.86 percent to $2.89. During trading, the shares dropped as low as $8.00 and $2.85, respectively.

To some degree their stock prices reflect a certain amount of dilution from issuing stock directly or converting preferreds, Todd added, noting this could explain why the shares did not fall further on the reports.

The cost of insuring Citigroup debt with credit default swaps rose 70 basis points to 615 basis points, while Bank of America's swaps widened by 25 basis points to 325 basis points, according to data from Phoenix Partners Group.

Bank of America and Citigroup, whose officials are objecting to the preliminary findings of the tests, plan to respond with detailed rebuttals, sources told the Journal, adding Bank of America's appeal was expected by Tuesday.

Wells Fargo Chief Executive John Stumpf, speaking at the bank's annual meeting, declined to comment on stress test results, and said the bank was strongly capitalized.

Bank of America spokesman Scott Silvestri declined to comment. Citigroup spokesman Jon Diat said in an emailed statement that regulators have prohibited all financial institutions from making comments on the results of the stress tests until the final results are announced.

A Federal Reserve spokeswoman also declined to comment. Diat could not be reached immediately later to comment on Citi seeking permission to pay bonuses.

MORE CAPITAL FOR WELLS, REGIONALS?

Financial stocks more broadly were also jarred by analysts' reports on Tuesday that other banks may need to raise funds.

Wells Fargo & Co could need more capital, according to a client note from Deutsche Bank analysts, and regional banks may also need to bolster capital levels, Oppenheimer & Co analysts said in a report.

The KBW Banks Index slid as much as 4 percent in morning trading before recovering most of its loss, and was down 2.9 percent at the close of the market.

Loan losses continue to get worse, charge offs continue to get worse, so of course (banks) need to continue to raise capital, said Jon Fisher, portfolio manager at Fifth Third Asset Management.

The government said that results of the stress tests on the 19 largest U.S. banks would be released next week. The 19 banks tested, which include JPMorgan Chase & Co and Wells Fargo, hold two-thirds of the assets and more than half of the loans in the U.S. banking system.

Some banks with too thin a capital cushion will have six months to find private funds; others may need to accept an immediate infusion of taxpayer money.

(Reporting by Ajay Kamalakaran in Bangalore, Elinor Comlay and Dan Wilchins in New York; Additional reporting by Paritosh Bansal in New York, Mark Felsenthal in Washington, Victoria Howley, Sitaraman Shankar and Steve Slater in London; Editing by John Wallace, Brian Moss, Matthew Lewis, John Stonestreet)